Europe, UK Rate Decisions; What to Expect

The biggest event risk this week for the Euro is the European Central Bank interest rate decision. Weak economic data and softer inflationary pressures will force the ECB to take interest rates below 3 percent.

A rate cut will not be a surprise since ECB President Trichet warned a few weeks ago that he plans on reducing rates at the November monetary policy meeting. As a central banker, Trichet is notorious for preparing the market for any imminent changes to monetary policy in the hopes that it will reduce volatility in the financial markets when the actual change occurs.

Another 50bp point rate cut is expected and with the strong possibility that a recession is already underway, there may be a need for further rate cuts. We expect Trichet to retain a dovish tone as he proceeds to close the gap between US and Eurozone interest rates which should be Euro bearish.

Downward revisions were reported in the final October purchasing managers indexes for Germany, Italy and France while Eurozone retail sales declined by 0.2 percent in September. As an export dependent region, a contraction in manufacturing activity spells big trouble for the overall economy.

With interest rates expected to fall to 2.5 percent over the next 12 months, the Euro will have a tough time moving back above 1.35.

Bank of England: Risk of 1% Rate Cut

Like the European Central Bank, the Bank of England will also be making a decision on interest rates tomorrow morning. However the difference between the ECB and the BoE is that we could see a much larger interest rate cut from the UK.

To be clear, the official forecasts for both central banks is a 50bp rate cut, but the word on the street is that the BoE could cut by as much as 100bp. For the UK central bank, a larger interest rate cut will depend upon how proactive the central bank wants to be. Economic data has been very weak with the service sector PMI index falling to a record low. Even though consumer confidence edged higher, industrial production dropped for the 5th consecutive month.

In October, the UK government openly admitted that the country has fallen into a recession. The European Commission believes that of any other mature European Union economy, the UK will suffer the sharpest contraction in growth. We expect the Bank of England to cut by at least 75bp.

A 50bp rate cut would be a big disappointment while a 100bp rate cut is exactly what the market needs. Either way, the outcome of the BoE rate decision should be pound bearish. Over the next 12 months, UK interest rates could fall to below 3 percent.

Kathy Lien is an Internationally Published Author and Chief Strategist of DailyFX.com, one of the world’s most popular online websites for currency research. Her trading books include the highly acclaimed, Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings (2005, Wiley); High Probability Trading Setups for the Currency Market E-Book (2006, Investopedia); and Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game (2007, Wiley).
As Chief Currency Strategist at FXCM, Kathy is responsible for providing research and analysis for DailyFX, the research arm of FXCM. She also co-edits the BK Forex Advisor, an Investopedia.com Premium Service with Boris Schlossberg – one of the few investment advisory letters focusing strictly on the 2 Trillion/day FX market.

Kathy is also one of the authors of Investopedia’s Forex Education section and has written for Tradingmarkets.com, the Asia Times Online, Stocks & Commodities Magazine, MarketWatch, ActiveTrader Magazine, Currency Trader, Futures Magazine and SFO. She is frequently quoted by Bloomberg, Reuters, the Wall street Journal, and the International Herald Tribune and has appeared on CNN, CNBC, CBS and Bloomberg Radio. She has also hosted trader chats on EliteTrader, eSignal and FXStreet, sharing her expertise in both technical and fundamental analysis.